Microfinance in Philippines
This Asia Focus report reviews the growth of the Philippines microfinance industry and discusses the mplications of commercial banks entering this market. What is Microfinance? The Philippines central bank, Bangko Sentral ng Pilipinas (BSP), defines microfinance as the provision of a broad range of financial services such as deposits, loans, payment services, money transfers and insurance products to the poor and low-income households and their microenterprises. ‘ The financial service most commonly provided is microcredit, which is typically issued in the form of a specific business loan for microenterprise purposes.
A key defining characteristic of a microfinance loan is the ability to secure credit without collateral. In the Philippines, microfinance loans cannot exceed PhP 150,000 Microfinance providers in the Philippines often employ a group lending approach, whereby each person within a small group is liable for any default by another group member. Other group lending- based methodologies being used in the Philippines include the ASA model, whereby each group member is responsible only for his or her own loan, and the Alliance of Philippine Partners in Enterprise Development (APPEND) Scale-Up Branch Model, which is based on the Trust Bank model. ii,iv Development of Microfinance in the Philippines The Philippines’ microfinance sector is credited as one of the oldest and most active in the world. v While the roots of microfinance activity date back to the early 1900s through cooperatives, microfinance, as described today, surfaced in the 1980s and was codified into national law in 1997 with the signing of the Social Reform and Poverty Alleviation Act (RA 8425), and the establishment of both the National Anti-Poverty Commission and the National Strategy for Microfinance.
With approximately 33% of the countrys 92 million population considered to be living below the poverty threshold, poverty alleviation is ne of the government’s top priorities and microfinance is a primary tool to address this issue. vi The ultimate goal of the government’s National Strategy for Microfinance is to create a sustainable private microfinance market, where the private sector limited to providing an environment which enables the market to thrive.
The General Banking Law of 2000, which mandated the recognition of microfinance as a legitimate banking activity, is one of the primary catalysts for accelerated growth and commercialization of microfinance over the last several years. The law empowered he BSP to create measures recognizing microfinance providers as banking institutions and to provide regulatory guidelines specific to the microfinance portfolios for institutions falling under the BSPs purview.
Furthermore, banks engaging in microfinance activities were given certain allowances and relieved of certain restrictions; for example, they were granted exemption from a moratorium on branch licensing. Today, the BSP defines its commitment to the development of microfinance in the Philippines in three specific ways: i) providing an enabling policy and regulatory environment, it) increasing the capacity of the BSP and banking sector ith respect to microfinance operations, and iii) promoting and advocating the development of sound and sustainable microfinance operations. ii Historically, the provision of retail microfinance services in the Philippines was achieved through rural and thrift banking organizations, as well as NGOs and finance cooperatives. Government financing programs also participated in the retail market. The BSP reports Asia Focus is a periodic newsletter issued by the Country Analysis Unit of the Federal Reserve Bank of San Francisco. The information contained in this newsletter is meant o provide useful context and insight into current economic and financial sector developments in the Asia Pacific region.
The views expressed in this publication are solely that of the author and do not necessarily represent the position of the Federal Reserve System. that government financing programs are transitioning away from direct retail business activities and toward providing wholesale funding for private microfinance institutions. Transitioning away from direct retail microfinance activity brings the government closer to achieving the ultimate goal of having a limited role in the icrofinance market, as outlined in the National Strategy for Microfinance.
Meanwhile, the private banking sector is playing an increasing role in the provision of microloans. Microfinance activity across the Philippines banking sector, as measured by the size of microloan portfolios at thrift, rural and cooperative banks, nearly doubled between 2005 and 2008 alone (see Chart 1). During the same time period, the number of microfinance borrowers grew by 40%. PhP Millions 7,000 6,000 5,000 4,000 3,000 2,000 1,000 – 2005 20062007 2008 Total Rural Banks Microloan portfolio
Total Thrift Banks Microloan Portfolio All data is as of June 30 Total Cooperative Banks Microloan Portfolio Source: BSP The Changing Role of Commercial Banks in Microfinance Traditionally, commercial banks’ role in the Philippines microfinance market has been exclusively through wholesale lending, by providing funds to microfinance institutions which then re-lend the funds in the form of microcredit, and the provision of general financial services to challenging operating environment due to the global financial and economic crisis, commercial banks are seeking new viable revenue options.
As a result, some commercial banks recently have entered into the retail microfinance market. For example, Rizal Commercial Banking Corporation, the nation’s seventh largest lender, acquired JP Laurel Rural Bank in February 2009 and issued its first microfinance loan in July through JP Laurel Rural Banks branches. x This marked the first microfinance retail operation by a large commercial bank in the Philippines. Since then, Asia United Bank, ranked twentieth by asset size, acquired Rural Bank of Angeles to take advantage of its microfinance network. i In addition, Bank of the Philippine Islands, he nation’s third largest lender and the first privately owned commercial bank to engage in wholesale microfinance lending, was granted permission to launch the countrys first mobile microfinance bank. xii Demand for microfinance loans is expected to increase considerably over the next year as a key part of the rebuilding of Metro Manila, which was severely damaged by typhoon Ketsana in September 2009.
Further demand is anticipated from displaced overseas Filipino workers, as a result of the global crisis, as these workers and their families turn to microenterprise business activities as a means to supplement family income. These increases in demand for microfinance loans, coupled with the reduced supply of microfinance providers resulting from the high rural bank closures in the last 18 months,xiii provide additional incentive for commercial banks, as well as other players, to enter the retail microfinance sector.
Risks and Benefits Associated with the Retail Microfinance Market As commercial banks begin to venture into retail microfinance, they face a range of challenges that are specific to the microfinance market. Microfinance is highly specialized. It requires the loan officers to have significantly ore personal knowledge of the microclient than is usually required for a client of a traditional loan.
It also calls for knowledge of the intrica- Chart 1: Microfinance Activity in Philippines Banking Sector In fact, a recent study by the Economist Intelligence Unit (EIIJ) assessing the microfinance environment within countriesviii ranked the Philippines first in Asia and third overall on its microfinance index, after Peru and Bolivia. The Ell-J microfinance index categorized its indicators into three main groups: i) regulatory framework, it) investment climate, and iii) institutional development.
Ell-J awarded the Philippines a perfect score for its regulation of microfinance activities at financial institutions, adding that “the government has promoted a regulatory environment conducive to microfinance operations. “ix While the Philippines also received a perfect score for the legal environment surrounding the formation and operation of specialized microfinance institutions, the Ell-J study highlighted a need to increase the diversity of microfinance products and services available to customers.
Until recently, the microfinance industry in the Philippines has been primarily focused on microcredit products. Lately, there has been a broadening of services to include savings and microinsurance, but the portion of microfinance providers in the Philippines that are offering such services remains small. inherent to microfinance. Traditional loan officers typically need extensive training before transferring into a microlending environment. xiv Furthermore, commercial banks may not have the infrastructure in place to reach micro-clients who often live in rural areas.
Toward this end, rural banks and NGOs have a competitive advantage in terms of specialized knowledge and necessary infrastructure; therefore, it is not urprising to see commercial banks entering the market through the acquisition of rural banks. Micro-clients are considered to be inherently risky, largely due to their extreme susceptibility to declining economic conditions and lack of information on their creditworthiness. This risk is somewhat mitigated by the use of the group lending methodology and more frequent repayment schedule options.
During challenging economic times, institutions engaged in microfinance activity face not only the risk of rising delinquencies, but also the risk of default of other financial nstitutions with payment or funding obligations to these microfinance institutions. xv This particular risk is less of an issue for commercial banks than for other microfinance providers, as commercial banks hold sufficient deposits and do not rely on donations or wholesale funding to finance their microfinance activity.
In addition, “credit pollution”, a term used in microfinance to describe when customers borrow from multiple institutions and often use loans from one institution to fund payments on a loan from another institution, is a growing problem in the Philippines microfinance market. This type of “pollution” appears to worsen as competition increases. As more microfinance players enter the market, micro-clients have more institutions from which to borrow.